BY DOUGLAS SMITH
Ecuador triggered its second default in ten years after Presient Correa confirmed Friday that the country would not pay the coupon on its 2012 global bond by next week’s deadline. The amount to be paid was $31 million. Correa said the debt – which was issued by prior governments – was “illegal”. The government will likely propose a restructuring to bondholders which will include a significant principal haircut. Not surprisingly, the ratings agencies will now move to classify Ecuador as in default and its bonds plunged on the news.
The decision not to pay was made on ideological grounds, not because of an inability to pay. As of end October, international reserves were $6.27 billion vs. $3.8 billion in sovereign debt which is largely in Eurobond form with maturities in 2012, 2015, and 2030. (There is also $4.3 billion in debt to the international financial institutions and $1.5 billion to the Paris Club and other bilateral creditors.)
Initial gut reaction is that this should not unsettle markets too much. LatAm markets did not fall on the news. In fact, the possibility of default had been in the open for some time now. That is clear from looking at bond prices/credit default swaps. Since the default was based on unwillingness to pay, we can take some “comfort” for lack of a better word that this may be an isolated event. However, with confidence so low globally, any kind of default is a clear negative.
Looking beyond Ecuador, one cannot help but speculate if there will be more defaults ahead for either ideological or inability to pay reasons. Argentina clearly comes to mind. It is well know that the government will face significant debt payments in 2010/2011 and will need to come to the international markets to rollover that debt or radically increase its fiscal surplus. But again this is well known and can be seen in the price of Argentine assets.
THE FT EFFECT
Perhaps the biggest negative implication for the region is simply the “Financial Times” effect. That refers to the fact that whenever LatAm is on the front page of the FT, it is usually for negative reasons and this will reinforce the view to some that the region is inherently unstable and needs to be treated very carefully. For example, that may mean tighter controls on lending into the region or second thoughts about FDI inflows.
Those of us who follow the region closely will not change our views as a result of this. Much lower vulnerabilities, counter cyclical fiscal policy, and wider trading relationships are only some of the many improvements in the region in the past 10 years that contribute to stability. Ecuador’s default will not change that but does remind us that we have to take account of politics as much as economics in our risk assessments.